ESG Economist - How will EU-ETS 2 nudge households energy bills?
The European Union Emission Trading System (EU-ETS) is the flagship climate policy in the EU. It has been around since 2005 and mainly covers emissions from electricity generation, heavy industry, aviation, and most recently international shipping. The remaining combustion emissions from the road transport, buildings, and other light industry sectors will be addressed in a separate system called EU-ETS2. EU-ETS2 will be phased in gradually with a monitoring and reporting phase starting in 2025 and the system shall be fully operational in 2027. Fuel suppliers, rather than consumers, will be responsible to report their emissions and surrender allowances. The new system envisions lower emission reduction targets of 43% by 2030 from 2005 levels, compared to 62% under EU ETS1. The system will cover main fuels like natural gas, gasoline, diesel, heating oil, Liquefied Petroleum Gas (LPG), and coal, which sometimes is used in some industrial settings. In an earlier note [1] we covered the main aspects of EU-ETS2 such as the phase in process, associated mechanisms, and potential dynamics. This note aims to highlight the channels by which ETS2 affects regulated entities, along with monetizing the expected impacts on households energy bills in the Netherlands.
Launching in 2027, EU-ETS2 targets emissions from transport, buildings, and light industry, aiming for a 43% reduction by 2030 from 2005 levels
It includes a Market Stability Reserve to prevent excessive price hikes, with a cap set for initial years at 59 €/tCO2 in 2027 prices
EU-ETS2 will increase heating and transportation costs, while euro area inflation could increase by up to 0.4pps in 2027, as consumer prices for goods reliant on transportation and heating will be affected
Average household energy bills could rise by 319 to 489 euros per year
Households can reduce costs by adopting energy-efficient practices and shifting to alternative transportation modes
Financial support via Social Climate Fund will aim to cushion the impact on low-income households by funding sustainable energy transitions
ETS2 pricing mechanism
ETS2 is a cap and trade system, where emissions from covered sectors are capped. The cap is translated into emission allowances, which are all auctioned. The cap is reduced at an annual linear reduction factor of 5.15%, which is higher than that under ETS1 (4.3%). However, the system embodies a Market Stability Reserve (MSR) that aims to monitor supply and prevents excessive prices increases. In that regard, the ETS Directive determines a threshold of 45 €/tCO2 (in 2020 prices). That is, if the price increases too quickly, or if the average price in two consecutive months exceeds a threshold during the initial years, additional allowances will be put in the market from the MSR to keep the prices below that threshold. This would entail a price cap of 45 €/tCO2 in 2020 prices, which would translate to 59 €/tCO2 in expected 2027 prices, for the first three years (2027-2030). In addition, the start of the compliance period is conditional on energy prices. That is, in case of exceptionally high oil and gas prices in 2026, the start of ETS2 could be postponed till 2028.
Channels affecting energy bills
EU-ETS2 will hit energy bills for final consumers through several channels. Some of these channels are direct and others are indirect. The direct channels relate to heating and transportation costs, where households relying on gas or oil for heating purposes and those using combustion engine cars will have to pay more for their usage through higher fuel prices. While indirect impacts would materialize as higher fuel cost will increase shipping and production costs and will increase overall price levels for goods and services in the economy. At the same time, the impacts on households will be mitigated by changes in behaviour in energy use along with the adoption of technologies and measures to reduce consumption, such as building insulations or travelling less, or even a switch to public transportation or electric vehicles.
The burden of the new system will be felt more by low income households who have to spend a relatively large proportion of their income on energy, along with households living in rural areas with fewer options for public transportation. In that regard, the Social Climate Fund associated to the EU-ETS2 aims to mitigate adverse impacts on vulnerable households and enterprises by providing financial support to invest in efficiency improvements, renewable energy, and clear mobility alternatives.
Effects on households pockets
Direct costs
In order to monetize the potential impact of EU-ETS2 on households and businesses in the Netherlands, as different types of fuel emit different amounts of carbon, we use the average carbon content of covered fuels per use (). Natural gas is mainly used for heating purposes in the built environment, while gasoline and diesel are the main fuels used for transportation in the Netherlands. Gasoline-E10 is the most used in gasoline cars, while Diesel-B7 is mostly used in diesel cars. The Tank to Wheel (TTW) emissions varies across the different fuels. On average, gasoline emits 2.176 Kg CO2-eq/liter, while diesel emits 2.468 Kg CO2-eq/liter. Natural gas (G-gas) is mostly used for heating with 1.779 Kg Co2-eq/m3 on average.
On average a gasoline car in the Netherlands would drive between 12.5 and 16.7 km per liter of gasoline, while a diesel car would drive between 14.3 and 20 km per liter of diesel. Accordingly, assuming a family drives 15000 Km per year on average, with an average carbon price of 59 €/tCO2, yearly transportation costs for Dutch households would increase by 115-154 Euros for gasoline cars, and by 110-153 for diesel cars.
The average Dutch household uses between 800-2000 cubic meters of natural gas for heating, warm water, and cooking purposes depending on buildings’ energy labels. With a 59 €/tonne carbon price, heating costs would witness an average yearly increase between 84 and 210 euros.
The table above summarizes our estimates. All in all, the energy bills associated to heating and transportation for an average Dutch households with a combustion engine car and a gas boiler would increase between 194 and 364 euros/year under a 59 €/tCO2 carbon price.
The reported direct costs do not take into account any administrative costs associated with allowances trading or other surcharges that could be incurred by regulated entities, which can amplify the impact of carbon pricing on final energy bills.
We remark that these estimates for direct costs are on the upper side for carbon price between 2027 and 2030. After 2030, the price cap on EU-ETS2 will phase out and the price rise could accelerate, inducing even higher transportation and heating carbon costs. Furthermore, the estimates assume a direct pass-through of costs. The reported costs could be lower in case of a lower pass-through rate.
Indirect costs
As mentioned earlier, there are other indirect costs that will also hit households with the introduction of EU-ETS2. Those costs concern overall price increases especially for products that rely heavily on heating and transportation, where businesses might opt to pass on the increase in fuel costs to consumers, such as agricultural produce from greenhouses, some building materials, chemical products, or metals. The ECB expects that the EU-ETS2 would increase inflation in the euro area between 0 and 0.4pps in 2027, with a milder impact in 2028 (see more ). The wide range for impacts is due to the uncertainty associated to the speed and pass-through to consumer prices. This relates to the timing of surrendering the allowances, where allowances for 2027 emissions are only surrendered in 2028, for example. Moreover, there are lags in repricing consumer gas contracts in some countries. However, the expected impact on inflation could be reduced if households shift away from fossil fuels in a quick and pre-emptive manner. All in all, with an average annual expense of 30,000 euros for a Dutch household, an increase in inflation by 0.4pps would add around 120 euros of indirect carbon costs on household expenditure.
Households may endure additional costs related to investing in energy efficiency measures in order to limit the impact of carbon prices on their energy bills, such as upgrading insulation, or installing led lighting and heat pumps in buildings.
Furthermore, some households could decide to shift towards an alternative mode of transportation, such as public transportation, cycling, or electric vehicles. Additionally, households could mitigate the impact of EU-ETS2 on their bills by adopting behaviour adjustments that lead to lower fuel consumption. For example, by altering habits, such as reducing thermostat setting or carpooling.
Conclusion
ETS2, set to take effect in 2027, marks a significant step in the European Union's climate strategy by expanding the scope of emissions regulation to include road transport, buildings, and light industry. For the average Dutch household reliant on combustion engine vehicles and natural gas heating, this transition will likely result in increased annual costs ranging from 319 to 489 euros. Beyond direct financial implications, EU-ETS2 is poised to drive behavioural changes as households seek to mitigate expenses through energy efficiency measures and alternative transportation options. The introduction of the Social Climate Fund underscores the EU's commitment to cushioning the impact on vulnerable groups, providing vital support for transitioning to sustainable practices. As the system phases out its price cap post-2030, stakeholders must prepare for potential further cost increases, emphasizing the importance of proactive adaptation strategies. Ultimately, EU-ETS2 represents both a challenge and an opportunity for households and businesses to innovate towards a more sustainable future, while contributing to the EU's overarching climate goals.